Developments in UK insolvency by Michelle Butler

HoC BIS Committee recommendations on the Insolvency Service: will they help?

Goodness, what a busy week it has been! Consultations, draft Regulations, a DMP Protocol, and a bit of a backlog of High Court decisions… but they will have to wait.

Although the release of the House of Commons’ BIS Select Committee’s report on the Insolvency Service has already been reported widely, I wonder if you, like me, sigh at the tone of the press coverage, which all seems to lie somewhere on the spectrum between cold neutrality and wholehearted support. Don’t you wish people would come out and say what they really think? Therefore, I thought I would give it a go…

“At present, individual debtor bankrupts have to pay an upfront fee of £525. Given the level of debt relief they can receive we agree with the Insolvency Service that it would not be unreasonable to increase that fee, possibly on a sliding scale. We also agree that the fee should not be automatically required to be paid up front but could be staggered along similar lines as payments to debt management companies. We will expect the Insolvency Service to set out progress in both of these areas in its response to this Report.” (paragraph 43)

It is clear that the Insolvency Service’s sums currently do not add up; something must change (and the BIS Committee made other recommendations to this effect). However, I had always thought that the charges relating to the bankruptcy process reflected the work carried out (setting aside the need for cross-subsidisation, which gives rise to another debate entirely). How does the service provided differ depending on a debtor’s level of debt? Whatever the individual’s liabilities, he/she has to go through pretty much the same process to enter bankruptcy as anyone else. True, the higher the debt level, often the more time-consuming the bankruptcy administration, but this is usually also reflected in the asset values, and as asset realisations attract a percentage fee, this already means that a high-liability bankruptcy is paying more.

I am not saying that individuals with large debts should not pay more, but I feel it is quite a step-change to structure fees, not as proportionate to the work undertaken, but to reflect somehow the level of debt relief that the individual is receiving. I am certain that it would not work in other fields of insolvency: could an IP justify basing the cost of putting a company into liquidation on the level of creditors’ claims, rather than on how much work was involved in preparing the Statement of Affairs and convening/holding the meetings? There is a Dear IP (no. 18, July 1991) warning against such a practice!

It is widely accepted that the cost of the petition and court fee restricts access to bankruptcy for many individuals. Graham Horne told the Committee that the Service would look at the DMCs’ model of paying fees in instalments. However, from the consultation and response on bankruptcy petition reform, it appears to me that the Service is looking only at the possibility of individuals paying instalments prior to entering bankruptcy, not after bankruptcy. Quite simply, this is not the DMCs’ model, which involves providing the service of administering a debt management plan whilst being paid the fee by instalments. It will be of little use to individuals to have to make payments to the Service… over how long, 6 months, 12 months..? but not get the relief of a bankruptcy order until the £700 (or more) is paid in full. I can imagine the Service’s suspense account soon bulging with countless numbers of one or two months’ staged payments from individuals who intended to go bankrupt, but because of the continuing stress of fighting off creditors they handed their affairs over to a DMC simply for a break from it all.

If a bankruptcy order cannot be made until the petition and court fees have been paid in full, it is still an up-front fee notwithstanding whether this is paid in instalments, and it will remain a barrier to bankruptcy for many.

Would the Service contemplate providing for the fees to be paid after bankruptcy? The Service already charges £1,625 to each bankruptcy estate and the report acknowledges that this is not recouped “in the majority of cases” (paragraph 35), so a post-bankruptcy application fee would simply be another unrecovered cost to write-off. There would be a few cases that could bear this cost, but then who really would be paying? The creditors.

Pre-packs

“We therefore recommend that together, the Department and the Insolvency Service commission research to renew the evidential basis for pre-pack administrations.” (paragraph 72)

Some have greeted this with an “oh please, not this old chestnut again!” Personally, I would welcome this step. Arguments against the use of pre-packs as a principle (or at least those that involve connected parties, “phoenixes”) usually relate to the perception that the connected party has achieved an unfair advantage – the directors have been able to under-cut their competitors because they have left creditors standing with Oldco and they have bought the business and assets at a steal. There is the additional allegation that there is no overall benefit to the economy because, whilst jobs may be saved in the business transfer from Oldco to Newco, jobs are lost in rival companies and/or with creditors. I think that the difficulty the insolvency profession has in responding to these arguments is that all IPs can do is their best, their statutory duty to maximise realisations of the insolvent company’s assets; even if these anti-pre-pack arguments were valid and that pre-packs were not good for the world at large, if IPs were to adjust their actions somehow to accommodate these wider concerns, i.e. resist completing a pre-pack in favour of a break-up or an expensive trading-on in the hope that an independent buyer comes along, they could be failing in their statutory duties.

If these arguments against pre-packs hold water, then let’s see the evidence and then watch the policy-makers decide whether some or all pre-packs should be banned in the public interest. In the meantime, all IPs can do is their best to fulfil their statutory duties in relation to each insolvency over which they are appointed.

One small point: I sincerely hope that the researchers avoid falling into the trap occupied by the pre-pack protesters. The arguments of unfair advantage and of creditors being left high and dry whilst the phoenix rises apply to business sales to connected parties, not to pre-packs. If an IP trades on a business in administration and then sells it to a connected party, the same allegations apply, don’t they? It seems strange to me that there is so much antagonism towards pre-packs when, really, I see little difference between a pre-pack administration and the Receivership business sales of the 1990s. In fact, I would suggest that pre-pack administrations are an improvement over Receivership business sales because at least the administrator is an officer of the court with wider responsibilities to creditors as a whole.

I’m not sure how the researchers will test the allegations. However, if they limit the research to a comparison of the direct outcomes of pre-pack sales compared with longer-running administration business sales, then I do not believe it will do anything to answer those who cry unfairness.

SIP16

“Despite the introduction of Statement of Insolvency Practice Note 16 and additional guidance, pre-pack administrations remain a controversial practice. The Insolvency Service is committed to continue to monitor SIP 16 compliance, but to make this effective, non-compliance needs to be followed through with stronger penalties by way of larger fines and stronger measures of enforcement. We have some sympathy with the concerns of the regulator R3, which argues that noncompliant insolvency practitioners are not made aware of the criteria on which they are being judged by The Insolvency Service, or given any feedback on their reports. We recommend that the Insolvency Service amend its monitoring processes to include feedback to each insolvency practitioner and their regulatory body where SIP 16 reports have been judged to be non-compliant. We further recommend that the criteria by which SIP 16 reports are judged should be published alongside the guidance.” (paragraphs 80 and 81)

This time I will cry: “oh please, not this old chestnut again!” Given the perceptions of unfairness surrounding pre-packs – or to describe the issue more accurately, business sales to connected parties – as explained above, it is not surprising that “despite the introduction of SIP16 and additional guidance, pre-pack administrations remain a controversial practice”. Even with 100% compliance with SIP16, the controversy would never fall away. SIP16 is simply about helping creditors to understand why the pre-pack sale was conducted; it will never answer the allegations that the practice of pre-packing businesses in general is unfair.

However, this limitation of SIP16 disclosures can never be an excuse for IPs failing to meet the requirements of the SIP. It is not beyond the ability of professional IPs to get this right.

Unfortunately, the key principle of SIP16 of “providing a detailed explanation and justification of why a pre-packaged sale was undertaken so that [creditors] can be satisfied that the administrator has acted with due regard for their interests” (SIP16, paragraph 8) does not fit well with a checklist of pieces of information. If an IP were to sit a creditor down and say “let me tell you why I did this sale this way”, I believe that it is very likely that, on a case-by-case basis, not every last detail required by SIP16 paragraph 9 would always be relevant to telling this story and it may even be that other factors not strictly required by SIP16 paragraph 9 would be valuable in helping the creditor understand. It makes me wonder how we got into this position – where unique stories describing a vast range of demised businesses and complex rescues are reduced to a monitoring exercise on a par with recounting Old Macdonald Had a Farm!

However, I repeat: this limitation of SIP16 monitoring should never be allowed to fuel the pre-pack critics. If IPs are being judged on strict compliance with SIP16, why can we not get it right?

There is no doubt in my mind that the absence of Insolvency Service feedback on each individual SIP16 disclosure has not helped. It also seems insensible to me that the Service would make these assessments and not inform each IP where they thought he/she had gone wrong. What on earth was the point of carrying out the review in the first place?!

However, I foresee a problem: in 2011, there were 1,341 appointment-taking IPs and 723 pre-packs. I appreciate that an average of 0.5 pre-packs per IP does not reflect reality, but even so it would seem to me that pre-packs are not that common; IPs might only conduct one or two each year and some IPs might go years before doing another pre-pack. In 2011, the Insolvency Service only reviewed 58% of all SIP16 disclosures, so there’s a big chunk of all SIP16s where no feedback is possible. In addition, 32% of the 2011 SIP16 disclosures reviewed were considered non-compliant by the Service. If our profession is lucky, it might be that these non-compliant SIP16s are being produced by the same bunch of IPs. However, my hunch (having worked in the IPA’s regulation department) is that sometimes an IP gets it right, sometimes he/she misses something. If this is the case, then years might pass before (i) an IP receives feedback on where he/she slipped up with SIP16 compliance and then when (ii) he/she can apply that feedback to his/her next pre-pack. Waiting for IPs to apply the Service’s feedback will not crack this nut: I suspect that, if the 2013 SIP16 monitoring report shows similar levels of non-compliance, there will be hell to pay!

Thus, I feel it is down to each and every IP to work at producing perfect SIP16 disclosures. Some may rebel at this formulaic approach to recounting the skills used in getting the best out of an insolvent company – I do! – but the threat of more legislation, which I suggest could be even more prescriptive and restrictive than SIP16, remains loud. Can we not just try to get it right?

Continuation of supply

“We recommend that the Department undertake a consultation as a matter of urgency on the rules relating to the continuation of supply to businesses on insolvency in order to assess whether a greater number of liquidations or further damage to businesses could be avoided if that supply was better protected.” (paragraph 86)

My personal view is that, whilst changes to S233 will be welcome, I do feel that some are over-egging the advantages. The BIS Committee picked up on R3’s research suggesting that “over 2,000 additional businesses could be saved each year, rather than being put into liquidation”, if suppliers were obliged to continue to supply on insolvency (paragraph 82). I bow to R3’s and IPs’ greater experience, however I cannot help but wonder whether companies really are resorting to liquidation, rather than trading on in an administration, simply because contracts with suppliers are terminated on insolvency. I would have thought that there were far more substantial barriers to trading-on that will remain even after S233 is changed.

Regulating the RPBs

“We agree that the Insolvency Service, in regulating the recognised professional bodies (RPBs), should have a wider range of powers, very much akin to those that the RPBs themselves have in disciplining their members.” (paragraph 97)

I note this simply because I was stunned at this non sequitur – none of the preceding paragraphs hinted that there was a problem with the RPBs that needed to be fixed or that this was any solution.

Having said that, personally I have no issues with the Service having such powers. In my experience at the IPA, whilst there may have been some tendency to want to push back on some of the Service’s recommendations from time to time (to be perfectly honest, usually more on my part than on the part of my employer!), it would always end up with the RPB taking the required action. I cannot see that the Service needs to be able formally to warn, fine, or restrict RPBs, but if it helps perception, why not?

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As I mentioned at the start, there were other Committee recommendations, which I would encourage you to read if you have not already done so, as I believe they help us to see how the profession is viewed from the outside and, whether we agree with them or not, those views will continue to influence the shape of our profession in the years to come.